Presentation_-_How_did_Uganda_Address_Economic_and_Budgetary_Reformsx_Lessons_for_South_Sudan

7/29/2019 Presentation_-_How_did_Uganda_Address_Economic_and_Budgetary_Reformsx_Lessons_for_South_Sudan

1/10

How did Uganda Address Economic and

Budgetary Reforms? Lessons for South Sudan

Prof E. Tumusiime-Mutebile, Governor, Bank

of Uganda

October, 2011


2/10

1

1. Introduction

Twenty years ago Uganda faced daunting economic challenges. The country had only just started

to recover from a long period of civil strife and economic mismanagement which had causedrampant inflation, the contraction of the productive base of the economy and of tax revenue and

brought large parts of the public administration to the verge of collapse. In the first half of the

1990s Uganda implemented bold economic reforms to tackle these problems; reforms which

restored macroeconomic stability, laid the foundation for a recovery of exports and tax revenues

and led to 20 years of sustained growth, averaging around 7 percent per annum. I dont want to

infer that the challenges facing the Republic of South Sudan today are fully analogous to those

which confronted Ugandan policymakers 20 years ago, but I believe that there are important

lessons which can be drawn from Ugandas experience which our colleagues in South Sudan will

find instructive. I will mainly focus my remarks on fiscal policy, partly because that is the

primary responsibility of the Ministry of Finance and Economic Planning in South Sudan butalso because fiscal policy lies at the heart of economic management in low income countries.

2. The centrality of fiscal policy to macroeconomic management

The first lesson from Ugandas experience of economic reforms in the 1990s which I want to

emphasize pertains to the centrality of macro-fiscal policy in macroeconomic management.

Macro-fiscal policy refers to the broad aggregates of fiscal policy; total governmentexpenditures, the size of the fiscal deficit and public borrowing, etc, rather than the details of

budget allocations. Macro-fiscal policy matters for macroeconomic management in all

economies but it is especially important in low income countries with very shallow financial

sectors which are too small to absorb public debt. In such countries, excessive fiscal deficits are

financed, as a last resort, by borrowing from the central bank. Such borrowing, in economies

which are poorly monetized, so that money demand is low, fuels rapid growth in the money

supply which in turn generates inflation. This was the case in Uganda throughout most of the

period from the 1970s to the early 1990s.

In the five year period from 1986/87 to 1991/92, immediately prior to the implementation of

fiscal reforms in Uganda, the Governments domestic borrowing requirement averaged more

than 1 percent of GDP. This may not appear large, but it should be seen in the context of a very

shallow financial system which was too small to absorb public debt (at the time the ratio of broad

money to GDP was only 6 percent). Because the financial system was so shallow, which was the


3/10

2

result of financial repression in the 1980s, the Governments domestic borrowing requirement

was funded by the central bank. The monetary financing of the budget led to the money supply

(broad money) expanding by 106 percent per annum on average in this period. With the money

supply growing so rapidly, it is not surprising that annual inflation averaged 108 percent per

year.

In the final quarter of 1991/92, reducing inflation was made the priority objective of fiscal

policy. Fiscal discipline to eliminate the Governments domestic borrowing requirement was the

key to bringing down inflation. Consequently, strict controls over Government expenditure were

imposed by the Ministry of Finance and Economic Planning (as it was called at the time). A

system called cash flow management was introduced, on which I will elaborate shortly, which

was designed to eliminate Government domestic borrowing. In fact, from 1992/93 onwards

through most of the 1990s, fiscal policy was designed and implemented to generate modest

domestic savings in the banking system (i.e. Government domestic borrowing was negative,averaging about 1 percent per annum), which created the room in the monetary system for the

central bank to begin rebuilding its foreign exchange reserves and for private sector bank credit

to grow, without generating inflationary growth in the money supply.

The results of this dramatic shift in the fiscal stance were profound. In the five years following

the implementation of the macro-fiscal reforms (1992/93-1996/97), money supply growth fell to

less than 30 percent per annum on average, which brought average inflation down to 6.6 percent

per annum. These developments are illustrated in charts 1 and 2 below which show governmentbank borrowing (chart 1) and annual inflation and broad money growth (chart 2).

The fiscal consolidation did not damage economic growth. Real GDP growth accelerated to an

average of 8 percent per annum in the five years following the reforms, from 5.7 percent per

annum in the five years prior to their implementation. In conditions of very high inflation, it is

very unlikely that real growth in output is constrained by a lack of aggregate demand; hence a

tightening of the fiscal stance will not reduce real growth. On the contrary, the reduction in

inflation brought about by fiscal policy reforms in the early 1990s laid the foundation for the

recovery of economic growth in Uganda, which as I noted at the start of this presentation, hasaveraged 7 percent a year since 1991/92.


4/10

3

Sources: Ministry of Finance, Planning and Economic Development, Bank of Uganda and

Uganda Bureau of Statistics

-3%

-2%

-2%

-1%

-1%

0%

1%

1%

2%

2%

3%

1987/88 1988/89 1989/90 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98

Chart 1: Government bank borrowing as a percent of

GDP; 1987/88-1997/98

0

50

100

150

200

250

1987/88 1988/89 1989/90 1990/91 1991/92 1992/93 1993/94 1994/95 1995/96 1996/97 1997/98

Chart 2: Annual Inflation and Growth in Broad

Money (M2), percent; 1987/88-1997/98

M2 Growth

Inflation


5/10

4

One further point on the subject of macro-fiscal policy that I would like to stress is the

importance of close cooperation between the Ministry of Finance and the central bank in

formulating a consistent macroeconomic framework. In particular, it is imperative that the level

of government domestic borrowing in the budget is consistent with all of the monetary policy

objectives of the central bank.

3. Control of public finances

The second lesson of Ugandas experience of economic reforms which I want to bring to your

attention is the paramount importance of centralized control by the Ministry of Finance over all

government expenditure and borrowing.

To implement macro-fiscal policy effectively it is essential that the Ministry of Finance controls

fiscal aggregates, such as total government expenditure. This is not just a matter of formulating a

sound fiscal policy. In many countries weak fiscal policy which jeopardizes macroeconomic

stability is the result of poorly designed institutional arrangements which allow line ministries

and other spending agencies to circumvent the Ministry of Finance to obtain budgetary

resources, either from government accounts in the central bank or by contracting loans from

domestic or external lenders.

Consequently, it is imperative that strong institutional controls are put in place to enable the

Ministry of Finance to exert control over all of the spending and borrowing by spending

agencies. In particular, spending agencies should not be allowed to access funds from

government accounts in the central bank, or obtain overdrafts from the central bank, without the

permission of the Ministry of Finance. Similarly, spending agencies should not allowed to

contract loans, either from domestic or external lenders, without these having been sanctioned by

the Ministry of Finance.

As I noted earlier, the fiscal reforms implemented in Uganda in 1992 to impose fiscal discipline

involved the setting up of the cash flow management system. This system was designed to enable

the MOFEP to control government spending. In particular it was designed to ensure that no

spending agency could access budgetary resources from the central bank without funds having

first been released to the account of that agency by the MOFEP. To implement the cash flow

management system, the MOFEP initiated a monthly release of budgetary funds to the individual


6/10

5

accounts of the spending agencies in the central bank, with the size of the aggregate release

being determined by macro-fiscal priorities; i.e. to enable Government to meet its domestic

borrowing target. The spending by line ministries involved the printing of checks which was also

controlled centrally by the MOFEP. No check could be printed against a spending agencys

account unless sufficient funds had been first released to that account to enable the check to be

honoured; spending agencies were not allowed to obtain overdrafts from the central bank. As

there was no other channel through which spending agencies could access budgetary resources

other than the monthly cash release, the MOFEP was able to impose a ceiling on the aggregate

expenditures of the spending agencies. As such the cash flow management system was crucial in

enabling the MOFEP to bring public spending under control in the 1990s.

It is also essential for the Ministry of Finance to control all borrowing by spending agencies and

all borrowing by other public institutions, such as state owned enterprises, which could create a

liability for government. Uganda has established legislative safeguards to control publicborrowing. The 1995 Constitution states that all borrowing by government must be approved by

Parliament. Ugandas Public Finance and Accountability Act of 2003 states that the power to

raise a loan on behalf of Government rests solely with the Minister of Finance, and that no other

person, without the prior approval of the Minister of Finance, may raise a loan or issue a

guarantee. These principles are extremely important for the control of public debt.

4. The strategic allocation of public expenditures

In a low income country with a weak private business sector, the allocation of public

expenditures provides the most important tool for implementing public policies and for shaping

development. If this tool is to be used to maximum benefit, it is imperative to identify strategic

public spending priorities and to formulate budgets which translate these priorities into practise.

Strategic public spending priorities should be derived from a national development plan of some

sort; for example if the plan emphasizes agriculture as a development priority, the spending

allocations in the budget should reflect this strategic priority, through for example allocations to

rural infrastructure and agricultural extension services. Operationalising these principles has

important implications for the way in which budgets are formulated.

In the 1990s in Uganda, budget processes were restructured to enable budgets to reflect more

closely the strategic priorities of the Government. The strategic priorities were set out in the

Poverty Eradication Action Plan (PEAP), which was essentially a development plan. To


7/10

6

implement the spending priorities identified in the PEAP, the budget was constructed using a

medium term expenditure framework, which allocated resources to broad sectors of the budget,

or programs. I want to highlight three aspects of this reform which I think will be important for

budget planning in South Sudan.

The first issue that I want to highlight is that a budget cannot be planned to reflect strategic

spending priorities unless it is a unified budget. In many developing countries the budget is

fragmented, often between current and capital budgets, with different processes (and sometimes

different institutions) governing expenditure allocations in the separate budgets. The capital

budget is often further fragmented because it is composed of disparate donor funded projects

driven more by the priorities of the individual funding agencies than the government. All

government expenditures should be brought into a single budget and made subject to the same

budget procedures and policies. In Uganda, the merger of the Ministries of Finance and of

Planning and Economic Development in 1992 was crucial in enabling the budget to be unified,because prior to this merger the Ministry of Finance has responsibility for the current budget and

the Ministry of Planning and Economic Development had responsibility for the capital budget.

Off budget spending of public resources should not be countenanced. This is the only way that it

is possible to formulate a coherent budget which actually reflects the strategic priorities of the

government.

Secondly, expenditure planning cannot be implemented properly on an annual basis, because

many public projects and programs are implemented over the course of several years, rather thana single year. As such it is necessary for spending agencies to be able to plan their spending in a

medium term framework. Spending agencies require a degree of predictability as to the

magnitude of budget resources which will be made available to them over the medium term. To

provide this predictability, the Ministry of Finance, Planning and Economic Development in

Uganda provides each sector of the budget with a rolling three year expenditure ceiling which is

set out in the MTEF. The sector expenditure ceiling is a hard budget constraint within which

each sector is expected to plan its medium term expenditures.

The third issue pertains to the respective responsibilities of the Ministry of Finance and thespending agencies in the budget process. As I discussed earlier, it is imperative that the Ministry

of Finance controls aggregate government spending, so that fiscal policy is consistent with

macroeconomic objectives. It is also necessary to centralize the process of determining strategic

expenditure priorities and thus the allocation of resources between the sectors of the budget. The

Ministry of Finance, as the custodian of public finances, should take the lead role in this although

it should be done in consultation with other institutions of government. In contrast, it is not


8/10

7

optimal for the Ministry of Finance to micromanage the budgets of spending agencies. Once the

sector expenditure ceilings have been determined, the institutions best placed to allocate

budgetary resources at the intra-sectoral level are the sectoral institutions themselves, such as the

relevant line ministries, preferably organised into sector working groups.

To conclude this section I want to stress that good budget planning is a prerequisite for utilizing

scarce public resources efficiently. Good budget planning requires that budget planners have a

clear sense of their strategic spending priorities and have the latitude to allocate their resources to

best meet their priorities, within a predictable and stable hard budget constraint.

5. Getting the prices right

I now want to turn away from fiscal policy and focus on economic management more generally.

The final lesson that I want to draw from Ugandas experience of reform relates to the role of

prices in the economy as a tool for determining resource allocation. In the 1980s, Uganda had a

heavily regulated economy, albeit one in which many regulations were only observed in the

breach. For example, Government imposed controls over key export prices, interest rates, the

exchange rate and access to foreign exchange. Controls over prices and scarce resources are

often superficially attractive to policymakers on the grounds that markets suffer from

imperfections or market failures and as such do not always allow resources to be allocated in a

manner which is socially optimal or accords with development objectives. This was themotivation for the regime of controls which characterized the Ugandan economy in the 1980s.

While it is certainly the case that markets are subject to imperfections which can distort the

allocation of resources, it is also true that government controls over prices are usually

counterproductive and can be disastrous if they prevent prices from balancing supply and

demand in important markets by large margins, as was the case in Uganda. I will give two

examples of this. The Government fixed the value of the exchange rate in the 1980s. Because the

exchange rate was fixed and inflation was very high, the real effective exchange rate, which

determines the competitiveness of exports and other traded goods, quickly became overvalued.

As a consequence exports slumped and Uganda suffered balance of payments deficits which

forced the Government to heavily restrict access to foreign exchange. In the second half of the

1980s the Bank of Ugandas foreign exchange reserves were less than one month of import

cover.


9/10

8

The shortages of foreign exchange meant that the economy was unable to import many of the

critical inputs needed for production. When the exchange rate was devalued in 1990 and

subsequently allowed to float (i.e. to be determined by market forces) in 1992, the

competitiveness of exports was restored, which triggered a strong recovery of exports in the

1990s. Furthermore, the floating of the exchange rate allowed the price mechanism to allocate

scarce foreign exchange. Foreign exchange was purchased by those for whom it was most

valuable. As a result the supply side constraints brought about by the foreign exchange shortages

were eliminated which allowed the economy to grow more rapidly.

A second example of the damage inflicted by controls relates to interest rate controls. In common

with many other developing countries, Uganda imposed ceilings on bank interest rates in the

1980s. As annual inflation rates almost always exceed the maximum interest rate allowed under

the controls, real interest rates were negative, often by a large margin. The consequences for

financial development were disastrous. The negative real interest rates led to the contraction ofthe deposit base of the banking system, leaving banks with fewer and fewer resources to

intermediate. As a result private sector credit virtually dried up. This was disastrous for the

business sector because bank credit is essential to oil the wheels of business. Once interest rate

controls were lifted in the early 1990s, the banking sector began to gradually recovery. In the

subsequent 20 years bank credit has risen from only 5 percent of GDP in 1992 to the current

level of nearly 17 percent of GDP.

The conclusion that I want to draw from Ugandas experience is that policymakers should bevery reluctant to impose controls over prices in markets, however strong the public and political

pressure is to do so. Governments in many countries are currently facing pressure to intervene

and control the prices of key commodities such as fuel, food and the exchange rate. Price

controls rarely achieve their objectives. Once controls over prices are imposed it becomes very

costly politically to alter prices. As a result controlled prices quickly become severely misaligned

with market realities, with very damaging consequences. Whatever the drawbacks of markets, it

is generally less harmful to the economy to allow markets to determine prices then to fix prices

by government fiat.

6. Conclusions

To conclude I will briefly summarize what I regard as the most relevant lessons for South Sudan

that we can learn from Ugandas economic reforms in the 1990s.


10/10

9

First, sound macro-fiscal policy is a prerequisite for macroeconomic stability in low income

countries. Because demand for government debt in the shallow financial systems of these

economies is very limited, a priority for fiscal policy should be to minimize the governments

domestic borrowing requirement. Failure to do this will risk inflationary growth of the money

supply.

Secondly, the Ministry of Finance and Economic Planning in South Sudan must put in place

effective mechanisms for controlling all expenditures by spending agencies and public

borrowing. Without this budget discipline cannot be enforced and the Governments macro-fiscal

objectives will be jeopardized.

Thirdly, budgets should be planned in a manner which allows scarce budgetary resources to be

allocated to strategic spending priorities. To achieve, the strategic spending priorities must beclearly identified and medium term expenditure allocations drawn up to reflect these priorities.

Spending agencies should then plan their budgets to best meet their sectoral priorities, with the

sector expenditure ceilings acting as hard budget constraints.

Fourthly, Government should resist the temptation to impose administrative controls on prices,

however strong the political pressure is to do so. Price controls create imbalances between

supply and demand which can be very damaging for the economy, leading to shortages of vital

commodities.

I want to end by wishing all of our colleagues from the Republic of South Sudan the very best of

luck. History has placed a huge burden on your shoulders to build your nation, its public

administration and economy.

Thank you for your attention.

Documents

Presentation_-_How_did_Uganda_Address_Economic_and_Budgetary_Reformsx_Lessons_for_South_Sudan